Profit, Wages, and Capitalists

Perhaps one of the most influential and popular economic theories over the past century has been the theory of exploitation. The theory, which found its footing, ironically, in the writings of Adam Smith, was mostly promoted by the writings of Karl Marx. The exploitation theory laid the groundwork for the more recent theories of Keynes and the overall prevalence of socialist economic policies in our society.

According to the exploitation theory, capitalism promotes a system of slavery wherein the labor of workers is exploited to attain profits on behalf of the relatively few businessman or capitalists. These capitalists are seen as parasites upon the masses. Never mind the steady increase in the standard of living and working conditions. If it weren't for government intervention and labor unions, we would all still be working for $1 per day and dying of black lung.
George Reisman* explains the framework of the labor theory of value, one of the main aspects of the exploitation theory:

This framework is the belief that wages are the original and primary form of income, from which profits and all other non-wage incomes emerge as a deduction with the coming of capitalism and businessmen and capitalists. The framework easily leads to the assertion of the wage earner’s right to the whole produce or to its full value. It itself is based on the further belief that all income which is due to the performance of labor is wages and that all who work are wage earners.

In order to illustrate this assertion, let us imagine a pre-capitalist economy, if there ever was such a thing. In this economy, each person is the sole producer of any given commodity. Thus, each person would sell his or her commodity for a price. According to this theory, all income received in this economy is supposed to be wages, not profit, because all income is received by workers. The conclusion Marx made from this theory is that profit did not exist before capitalism because all income was wages. Thus, the advent of capitalism brought profit, at the expense of the wages of the laborer.

Marx says that in this pre-capitalist economy, production follows the sequence C-M-C. That is, a worker produces a commodity (C), sells it for money (M), and then buys other commodities (C). Here there is no exploitation because there is no supposed profit; all income is wages. Profit, or surplus value, comes about with capitalism which follows the sequence M-C-M. The capitalist spends money to pay for materials, machinery, and wages, a commodity is produced, and the commodity is sold for a larger sum of money than it cost to produce. The difference is profit.

Many non-Marxist economists actually ascribe to this framework but reach differing conclusions about profit based on the law marginal utility and time preference. These arguments are valuable, but they miss the point: the framework itself is flawed and needs to be re-evaluated. The definitions of the terms profit, wages, and capitalist themselves serve in restructuring the idea of a proto-capitalist economy.

• Profit is the surplus in money received from the sale of commodities over the money costs of producing them
• A capitalist buys products in order to sell them at a profit
• Wages are money received in exchange for the performance of labor--not the products of labor, but the labor itself

It follows from these definitions that if there were only workers who made and sold their commodities, the money received from the sale of their commodities is not wages, but profit. In buying commodities, one does not pay wages, and in selling them, one does not receive wages. These roles are performed by the capitalist. Now, in the strictest sense, the workers in this economy are not capitalists because they have incurred no money costs in the production of their goods. Still, they have acted as capitalists in that they sell their products, not their labor, for money. Thus, all income received is profit, not wages.
Reisman* explains again, better than I can:

Wages are not the primary form of income in production. Profits are. In order for wages to exist in production, it is first necessary that there be capitalists. The emergence of capitalists does not bring into existence the phenomenon of profit. Profit exists prior to their emergence. The emergence of capitalists brings into existence the phenomena of wages and money costs of production.

Accordingly, the profits which exist in a capitalist society are not a deduction from what was originally wages. On the contrary, the wages and the other money costs are a deduction from sales receipts—from what was originally all profit. The effect of capitalism is to create wages and to reduce profits relative to sales receipts. The more economically capitalistic the economy—the more the buying in order to sell relative to the sales receipts, the higher are wages and the lower are profits relative to sales receipts.

Thus, capitalists do not impoverish wage earners, but make it possible for people to be wage earners. For they are responsible not for the phenomenon of profits, but for the phenomenon of wages. They are responsible for the very existence of wages in the production of products for sale. Without capitalists, the only way in which one could survive would be by means of producing and selling one's own products, namely, as a profit earner. But to produce and sell one's own products, one would have to own one's own land, and produce or have inherited one's own tools and materials. Relatively few people could survive in this way. The existence of capitalists makes it possible for people to live by selling their labor rather than attempting to sell the products of their labor. Thus, between wage earners and capitalists there is in fact the closest possible harmony of interests, for capitalists create wages and the ability of people to survive and prosper as wage earners. And if wage earners want a larger relative share for wages and a smaller relative share for profits, they should want a higher economic degree of capitalism—they should want more and bigger capitalists.

*George Reisman's complete article on capital and the exploitation theory originally appeared in The Political Economy of Freedom Essays in Honor of F. A. Hayek, Edited by Kurt R. Leube and Albert H. Zlabinger (München and Wien: Philosophia Verlag, The International Carl Menger Library, 1985).
The article can be accessed in pdf form here